.... in five years would your investment be worth more than $102, exactly $102 or less than $102?  (Interest is reinvested.)  There are tools and calculators on this site to help you improve your financial literacy plus do a lot more.

Research suggests that many Australians may struggle to give the correct answer of more than $102.
Writing in the online investment newsletter Cuffelinks, Sydney investment consultant David Bell reproduces eight questions, including the one above, that are commonly used in an effort to measure financial literacy.

In his article - Do clients understand what advisers are saying? - Bell lists five basic questions, and three somewhat harder questions, which have been "Australianised" by researchers and tested against Australian adults.

Here's another of the key questions used to measure financial literacy: Is it true or false that buying shares in a single company provides a safer return than buying units in a managed fund? The correct answer, of course, is "false".

Diversification by investing in a managed fund rather than a single company spreads an investor's risk.
It would be an interesting exercise for anyone saving for retirement to read Bell's article and test how many questions they can answer correctly.

A recent research paper - Financial literacy and retirement planning in Australia by academics Julie Agnew, Hazel Bateman and Susan Thorp# - summarises the importance of financial literacy for investors, particularly given Australia's compulsory super system.

"It is difficult for individuals to make effective financial decisions if they are unable to apply basic mathematical calculations to their situation," Agnew, Bateman and Thorp write.

"Decisions such as allocating assets in retirement portfolios, determining savings rates, evaluating mortgage product options, and/or managing credit card debt require individuals to possess an understanding of how to calculate compound interest as well as an asset's risk and return," they emphasise.

Without doubt, financial planners face the challenge of not only giving advice but trying to ensure that their clients understand that advice. And no doubt, many individuals with low levels of financial literacy would not recognise the value of gaining that advice in the first place.

In short, a lack of financial literacy precludes many individuals from properly participating in the general financial and investment systems.

# Julie Agnew, the Mason School of Business in Virginia; Hazel Bateman, Australian School of Business, University of NSW; Susan Thorp, UTS Business School, University of Technology, Sydney.

By Robin Bowerman
Smart Investing
Principal & Head of Retail, Vanguard Investments Australia
10th December 2013